One of the main questions that I have returned to at various times over the course of the last year has concerned the true motivation of the U.S. regulators in proposing the various ABS regulations. As these pile up one by one, the cumulative burden placed on the securitization industry is very troubling, especially when combined with other prudential rule-making such as revisions to the Basel capital standards and the implementation of Basel III and the new accounting standards embodied in FAS 166 and 167. I concluded my year-end piece with the observation that the final rules would reveal the SEC's true intentions towards the securitization market; whether it wants to regulate a revitalized securitization industry or simply to make sure that it can never cause problems again. At that time, I promised to take stock again as matters develop. It appears that at least two of the heavyweights in the U.S. ABS market have decided that the proposed Dodd-Frank Risk Retention Regulations have in fact revealed those intentions clearly enough for them to take firm action now.
Despite the fact that SEC announced last week that it was extending the comment period until August 1, each of the American Securitization Forum (ASF) and the Securities Industry and Financial Markets Association (SIFMA) chose to file massive comment letters on the original due date. In so doing, they have planted their standard in firm opposition to the Proposed Regulations, presumably hoping to thereby rally opposition around it. Each of them raise the alarm over the threat posed by the Proposed Regulations to the securitization market although they have come at it from slightly different perspectives. ASF's main concern appears to be that the rules would unduly interfere in areas of the market which in fact continued to perform during the financial crisis (a mantra which, incidentally, has been chanted by us and many others in respect of the Canadian market as a whole). SIFMA, on the other hand, simply contends that the regulators have exceeded the mandate of the Dodd-Frank Act. Both of them see the result as being potentially devastating to the securitization market.
According to ASF:
"Despite the efforts of the Joint Regulators, significant work still needs to be done to evolve the Proposed Regulations into workable solutions. What is at stake is the risk of significant reductions in the availability of auto loans, mortgages, student loans, credit cards, and commercial credit all across America. Given that many engines of the U.S. economy are still sputtering and unemployment remains extremely high, the ASF advocates strongly that these rules not overreach to attempt to "fix" sectors of the securitization markets that did not see any losses during an extreme economic downturn and instead are now powering economic revival in some areas of the economy. Attempts to realign incentives in many types of securitization structures, where those incentives have demonstrated through strong performance to be well-aligned between issuer and investor, only serve to risk harm to the American economy, American consumer and to investors."
SIFMA is, if anything, even more scathing:
"[The Proposed Regulations] would change market practices, and impose specific economic costs on securitizers, which will likely be passed on to consumers of credit. We are concerned that the impact on certain asset classes would be extreme, and detrimental to borrowers and the broader economy...The need for fundamental reconsideration of the approach taken by the Agencies to fulfilling the statutory mandate that credit risk be retained in most securitizations could hardly be more urgent...We believe that Congress intended what the Dodd-Frank Act provides for, and that is retention of at least 5 percent of the credit risk related to securitized assets – not an artificial mechanism to limit profitability and discourage securitization...We note with concern that some market participants are so disheartened by the approach taken by the Agencies in drafting the proposed credit risk retention rules that they are speaking in terms of having one year, or two years, remaining "to get deals done" — a reference to the effective dates of the risk retention rules for residential mortgage-backed securities and other ABS, respectively. The industry as a whole needs to be able to approach implementation of the proposed rules in a positive, constructive spirit. In order to do that, we will need sensible, reasonable rules that will fulfill the statutory mandate for "skin in the game" while still permitting securitization transactions to take place."
Each of ASF and SIFMA reserve their main vitriol for the proposed premium capture provision. ASF claims that it exceeds the mandate and legislative intent of Dodd-Frank by adding on to the 5% risk retention requirement the entire value of ABS issued in a securitization over par "effectively nullifying the securitizer's entire return on the transaction ... [and eliminating] all incentives to securitize other than those that securitize purely for financing."
Furthermore, although the rules purport to permit a number of methods of risk retention in conformity with existing market practices, it is contended that the definitions of, and the requirements for, those methods would in fact not accommodate existing practices, but rather contain "significant differences that would create major disruptions in the ABS market." According to ASF,
"If the risk retention rules are not appropriately designed to accommodate existing market practices, we risk an immediate and significant reduction in the availability of auto loans, student loans, credit cards and business credit throughout our country without gaining material improvements to the risk retention practices that protected investors even during the worst of the financial crisis. The risk of shutting down the securitization markets is not warranted where investors have been protected by existing risk retention methods. Therefore, it is imperative that the provisions of the Proposed Regulations accommodate existing market practices that effectively align the interests of sponsors with those of investors.
SIFMA also highlights the manner in which risk retention is to be calculated which, they contend, would result in risk retention in an amount far greater than 5 percent of the credit risk of the securitized assets. According to SIFMA, this proposal (together with the premium capture provision) could be "so burdensome that significant segments of the ABS market could simply shut down...The effect of these provisions could be to render many securitizations uneconomical by substantially increasing the amount of risk required to be retained and reducing or eliminating the profitability of securitization transactions...SIFMA has described the potential impact of the proposed risk retention rules as 'monumental' and we do not exaggerate."
Each of SIFMA and ASF call for substantial revision of the proposals. SIFMA contends that the Agencies have failed to properly weigh the costs of compliance and the impact of the Proposed Regulations on the capital markets. While they accept and support the principal of mandatory risk retention required under Dodd-Frank, they suggest that the regulations must implement the statute "in a manner that accomplishes the statute's purpose without doing more damage to the capital markets than is necessary and reducing the availability of credit". They believe that the Joint Regulators have rushed to make the Dodd-Frank deadline and in so doing have "missed the mark in many key areas and failed to achieve the recommendations of the risk retention studies mandated by Dodd-Frank". They need to "step back, and reconsider the proposal, and take the time to get it right". They each call for a re-submission of the proposals for further consideration and public comment prior to adoption. "We strongly believe that this course of action will better enable the Joint Regulators to ensure that the final regulations achieve the goals of Dodd-Frank while promoting a healthy and vibrant securitization market".
It thus appears that the battle south of the border has finally been well and truly joined and should make for interesting theatre. However fascinating and entertaining it may turn out to be, however, the fact that we have been spared our own version is something to be thankful for.
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